Production declines outside of OPEC: China

Media and market observers tend to focus on the record inventory levels of crude and refined gasoline in the USA and “stored at sea”. There is no arguing that inventories are much too high and that before they are reduced substantially, it’s hard to see a scenario where oil prices increase. Stepping back and looking at supply destruction, however, it looks increasingly likely that on a medium-term view, fundamentals support higher crude prices. Chinese domestic crude production is a good example of this.

China reported that its crude oil production in July fell over 8% year on year and is now at its lowest levels since October 2011. This is the fifth straight month of declines, in terms of daily output, from the world’s fourth largest crude producer.

The two dominant domestic producers in China have suggested that low oil prices limit their incentive to keep many of their wells operating. Further, both Sinopec and PetroChina have projected declines in their domestic output, given that many fields are operating at a loss with the lower oil prices.

Given the low price of oil, many of the oilfields in China are no longer economically viable to produce, and are nearing their end of life. For example, Daqing, which came in in the early 60’s and is China’s largest oilfield, is expected to decline at its fastest rate in 20 years (over 7% this year).

It is important to note that China is not alone in this situation. Most of the OECD oil producing nations are experiencing (and projecting) significant declines in supply growth over the next several years and this provides an excellent example of how market forces are setting oil prices up for higher levels in the future. The old adage we’ve used many times before, “the best cure for low oil prices is low oil prices,” continues to prevail.

Here at TAG, the management and board continue to work at setting the company up for the next upcycle and the return of higher oil prices. This includes cutting costs to maximize profitability when higher prices return, making key hires in strategic roles (sub-surface and operations), and building out a long-life, low-cost, wide-ranging portfolio of opportunities from development through high-impact exploration. This, in our view, is the key to building long-term shareholder value.